The next few months may provide the right opportunity to examine 2012 prices, start setting goals for your marketing, and then start protecting your milk price.

By Steven Schalla, Stewart-Peterson

Two weeks ago, both milk and cheese prices saw a sharp decline that brought shivers down the spine of milk producers everywhere. Questions of “Is it over already?” or “Are prices going back to $10?” flooded our office. Even producers that I know to have the thickest of skin were on edge with flashbacks 2009.

The good news in the short run: It appears that cheese and milk prices have found some stability around the $1.65 price level for cheese and $16.50 level for milk. Friendly milk production and cold storage reports, along with firm international prices, have helped milk minimize the damage and keep many long-term indicators pointing higher.

But the recent drop has been a cold reminder about how quickly things change, sparking further talk about the “three-year milk price cycle” and risk of low prices in 2012. Since the start of the milk futures in 1996, and the first major low point in 1997, there has been a general pattern of reaching a low point every three years. The timeframe from low-point to low-point has ranged from 30-40 months, with not much consistency as to when the major high happens within that cycle.

The last major low was either January 2009 or June 2009, depending on which signal you choose to use as your bottom. This means that March 2011 is month 21 or 26 within this cycle. Not to worry though. As I hinted above, milk doesn’t look over quite yet, and deferred prices have actually strengthened over the past two weeks.

Looking ahead, the next few months between now and summer may provide the right opportunity to examine 2012 prices, start setting goals for your marketing, and then start protecting your own milk price. Currently these prices range from $15.60-$15.85.

International influence will be a key determinant of how long this cycle can last. Both dairy product supplies as well as milk production in key exporting regions will be critical to our milk prices.

In addition, grain prices will have an influence on milk marketing decisions as overall profitability continues to be a concern. Grain prices over the past months have been equally volatile as milk prices, and it is well known that any major weather disruptions this growing season could bring sharply higher grain prices. On the other hand, a smooth growing season could bring sharply lower prices by harvest as stocks-to-usage ratios ease.

Hedging milk, or any farm commodity, beyond nine or 12 months away is going to present a few extra challenges for which to be prepared. Here are three key considerations as you look at hedging for 2012:

·Consider volume. Like most commodities, milk has most of its volume take place in the closest few contract months. Therefore, you may need to work your futures or forward contracts prices over the course of a few days to get them done, or be prepared to compromise between your asking price and the best bid price to get it done quickly.

·Consider costs. Be aware that option prices will be very expensive, with a ton of time between now and then. This can actually work to your advantage if you consider some of the advanced option strategies such as a fence (min/max) or a put option spread. While these strategies do have their limitations, they will get you in a practical, cost-effective position.

·Consider your emotions. When considering establishing hedges on milk a year or more away, be mentally and emotionally ready to ride out market swings. It’s almost certain that at some point your hedges will look really good while at another point they may not. What’s key to remember is your ultimate goal with each position and not get emotionally up or down on yourself for the decision you’ve made.

With goals set in advance and the right strategy prepared now, you will find it easier to execute and manage the risk to your farm when prices do head south once again.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2011 Stewart-Peterson Inc. All rights reserved.

Livestock Gross Margin for Dairy has made a big surge forward in the last three months, with about 1.8% of the milk in the country covered under the risk management program.

By Marv Carlson, Dairy Gross Margin, LLC

Livestock Gross Margin for Dairy (LGM-Dairy) has made a big surge forward in the last three months. As of Feb. 25, about 1.8% of the milk in the country is covered. This compares to coverage by futures and options of 3% to 5%.

There are two reasons for the increased use of the LGM-Dairy product. First, the industry is in need of having a way to manage risk. LGM-Dairy fits that bill with an option-like floor price for gross margin. If prices of milk move lower and prices of feed move higher, the dairyman has a floor price. If the prices of milk move higher and the feed moves lower, he sells his milk in the marketplace at the higher prices. He has achieved the goal of supporting cash flow without putting a top on his income.

The second reason for the increases is the change in the LGM-Dairy product. First, the producer pays the premium at the end of the insurance period. Second, the RMA/USDA is now subsidizing the premium by 18% to 50%, depending upon the deductible selected.

Dr. Brian Gould from the University of Wisconsin has a premium estimator that he created and supports. This calculator allows the dairyman to look at the prices of milk, corn and soybean meal and get an estimated premium. Then, the last Friday of the month, the policy can be purchased through a crop insurance agent licensed to sell LGM for Dairy.

Historical data and other information can be found on our website at www.dairygrossmargin.com. Go to Premium Estimator to access Dr. Gould’s premium estimator. Go to History to review historical data regarding LGM-Dairy.

Summary of the LGM for Dairy policies for this 2011 crop year follows:

To give you an idea of the averages, first a look at some states individually. Then look at RMA’s data in the big chart at the end.

Dairy producers often hesitate to contract because they're afraid they'll miss out on potentially higher prices. But you can maintain your business in any price cycle if you consistently contract a price that satisfies your farm's needs.

By Katie Krupa, Rice Dairy

Regardless of location, herd size or management style, dairy producers across the country struggle when making risk management decisions.

It is difficult to find the right broker, choose an appropriate strategy, and then know when to contract. For most producers knowing when to contract is the most challenging decision. Current market volatility and contradicting projections from market analysts have many producers panic stricken, afraid they will make the wrong decision for their business.

So how do farm managers make the right risk management decision? The right risk management decision is different for every farm and should primarily be based on the farm’s financials.

Before any strategy is determined, or any broker advice is given, the farm should determine an adequate milk price for the operation. Many farms will work with their lender, accountant or even their broker to review the farm’s financials. Once an adequate milk price is determined, current trading prices can be reviewed and a strategy established.

I frequently talk with dairy producers who are hesitant to contract because they are afraid they will miss out on potentially higher prices. For example, if a producer contracts a portion of their Class III milk price at $16.00 per cwt., and the Class III price settles at $17.00, the producer will be paid $16.00, and miss out on the $1.00 of upside potential. Wrongly, many producers will be disappointed in their contracting decision, and shy away from contracting in the future.

Let’s back up and examine why the producer contracted milk at $16.00. In this example, the dairy producer determined the farm’s break-even price was $15.00. Therefore, he or she decided to contract at the price of $16.00 to ensure the farm a profit of $1.00 per cwt. The farm made a thoughtful, calculated decision that it would lock in the $1.00 profit, rather than leave itself unprotected against the volatile milk market.

In this example, the milk price moved higher than the producer’s contracted price, but that will not always be the case. Dairy farmers understand how volatile the milk price can be, and there will be months when the milk price moves higher than their contracted price, and months when the milk price drops below their contracted price.

To have a successful risk management strategy, you should consistently contract a price that satisfies your farm’s needs. We all know the milk price will go up and down, so having a consistent strategy is critical to managing price volatility. If you are consistently protecting a profit, or at least covering your break-even price, you will be able to maintain your farm business in any price cycle. As the old saying goes, no one ever went broke making money.

A broker should be able to help guide your decisions and provide market insight to make sure your strategy is appropriate for the current trading environment. The dairy market can change quickly, so your risk management strategy should be flexible, and be able to adjust as the market shifts.

To get a better understanding of how your risk management strategy will play out in different markets, run through several scenarios. If the Class III price settles at $10, what is your milk check price? If the Class III price settles at $24, what is your milk check price? A strategy that is appealing if the Class III price declines may not be appealing if the Class III price increases.

In addition to milk price risk management, a complete risk management plan should also include input costs. Input costs and risk management strategies to protect inputs vary greatly across the country. Regardless if you grow or purchase most of your own feed, you are subject to input price volatility. All producers should review their cost structure and determine where they are most vulnerable to price fluctuations and manage that risk.

Input price management is also very diverse and can include contracting on the exchange, contracting with local mills, utilizing the USDA’s Livestock Gross Management program, or a combination of strategies.

There are many different strategies you can employ to protect your milk price and your input costs. Your strategy should depend on your farm financials, debt level and even your personality. Working with a broker who takes the time to ask the appropriate questions, and understands your business’s financials will help you create the best risk management strategy for your unique business.

Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at klk@ricedairy.com.Visit www.ricedairy.com.

If we recognize that we can’t beat the market, then we’re well on our way to developing a hedging program that seeks to smooth out the bumps in the road rather than pick every top and bottom in the market.

By Will Babler, First Capitol Risk Management, LLC

This is one in our series of articles written to aid dairy producers in moving up the learning curve toward a structured hedging approach. We believe this approach is necessary for producers to succeed and compete going forward.

Hedging Philosophy

Your hedging philosophy is the most basic philosophical foundation for future hedging decisions. The temptation for commodity producers to move from a basic understanding of hedging tools straight into a trading (or speculative) approach is often too great to resist. This speculative desire to “be right” and “beat the market” often leads to ruin and typically stems from having the wrong initial philosophical mindset. Taking a step back and making an honest assessment of what we know about commodity markets and what we should expect from a hedging program is a great way to maintain a hedger’s mindset and avoid the traps of speculating.

What We Don’t Know about Commodity Markets

It may be unexpected to initially focus on what we can’t know for certain about commodity markets. With market pundits making bold claims about market turning points and price objectives, it’s easy to overlook the fact that very few people, if any, can consistently out-guess the market over the long-term. If the historical empirical record isn’t sufficient to demonstrate this, then it should only take an individual a matter of years (or weeks) attempting to successfully speculate in commodities to realize this fact.

With this in mind, consider this abbreviated list of what we, even as market professionals, have come to learn over the years that we don’t know about commodity markets:

·When they will peak

·When they will trough

·When they will turn around

·How high they will go

·How low they will go

·How long they will stay where they are

In case we haven’t made it clear, the main point here is that trying to outguess the markets consistently over a long period of time is a fool’s game, and producers and other commodity traders should be careful not to confuse skill with luck.

What We Do Know about Commodity Markets

While we freely admit we can’t know what commodity markets will do with certainty, it’s still useful to understand their characteristics. We can use the following short list of things that we do know about commodity markets in order to define potential risk:

·Markets are unpredictable. Even though “black swans” may be in vogue, it hasn’t become any easier to foresee outlier events that will drive commodity markets. Factors such as weather, geo-politics, technology and human behavior will continue, until further notice, to be wildly unpredictable. Still, an understanding of fundamental supply and demand trends and emotional tendencies is useful for projecting risk boundaries, as long as outliers always remain in consideration.

·Markets follow patterns . . . until they don’t. There are many regular cycles in commodity markets related seasonally to production, processing and consumption patterns. There are also longer term cycles in investment and the business cycle. These patterns can be useful for defining risk, but shouldn’t be relied on in their entirety. Markets behaving contra to their cyclical tendencies need to be taken at face value, and producers should move forward with a hedge that appreciates the possibility that the typical pattern may not unfold during that cycle.

·Markets are indifferent to your circumstances. As volatility unfolds in commodity markets, often the pricing and supply and demand dynamics are set on the margin. Whether or not your circumstances place you on the right side of the margin is difficult predict, but, regardless, any one producer is not big enough to influence the market. Therefore, those engaged in commodity businesses should be prepared to deal with volatility forces they can’t control by working on factors that they can control, such as managing the cost of production, maintaining liquidity and executing on hedging programs.

Objectives and Expectations for a Hedging Program

We would like to reiterate that commodity markets (and dairy production margins) have been volatile and will continue to be volatile. If we recognize that we can’t beat the market, then we are well on our way to developing a hedging program that seeks to smooth out the bumps in the road rather than pick every top and bottom in the market. Consider the following specific objectives of a hedging program that is operated by a producer with realistic goals:

Margin Management Hedging Objectives

·To minimize risk

·To capture opportunity

·To smooth out earnings

·To avoid disruptions to operations

·To execute on long term business plans

With these objectives in mind, a hedging program can be developed that utilizes the appropriate tools for a given producer. Our next article in this series will dive into more detail on how to choose the appropriate tool.